When you buy into a mutual fund, you have to pay for the expertise of the fund manager and the research that goes into choosing assets for that fund.
That cost can vary widely between funds. As a result, some experts believe you should stick to funds with the lowest available costs. In other words, why should you be paying any more than absolutely necessary, when that cost comes directly out of your pocket? This is not a bad strategy, but it may not always be the best idea for your situation.
Let’s look at an example. Say an investment returns 10 percent and the cost is 1 percent; in that case, your net return is 9 percent. If another investment with the same return costs only a quarter of a percent, your net grows by three-quarters of a percent, to 9.75.
So the argument says that if two funds perform identically, only a fool would take the higher-cost choice. Makes sense, no?
The problem is that “if” is a troublesome word. If two investments return the same, then yes, you should go for the lower cost. But your pursuit of low cost should not overshadow an investment’s potential earnings or the way it fits into your overall investment strategy. Considering cost is wise as a factor in your investment strategy but unwise when it becomes your investment strategy.
This is one reason it makes sense to work with a CERTIFIED FINANCIAL PLANNER™. Everyone loves a bargain, but a bargain that hurts you financially is no bargain at all. In essence, we are here to serve as your professional reality check, looking after your long-term financial goals and your bottom line
My other business, Heritage Investors, recently encountered a case that demonstrates the point. We were working with one of our most sophisticated clients—someone who is also a financial professional—and looking for a small cap value position (“small cap” meaning smaller-sized company, and value referring to stocks that may be undervalued).
Our client wanted the lowest-cost, highest-rated investment available, and we found one where the rating was good and the cost was just 0.25 percent.
The problem was that the historical return on that investment had barely matched or just slightly exceeded the applicable index—in this case, the Russell 2000. On the other hand, I was also able to find a fund that had outperformed this index by almost double digits. And while past performance is no guarantee of future earnings, it should definitely be considered.
The catch with this second investment was that it cost 1.3 percent. However, my client and I decided together that there was a good reason for that higher cost: the fund manager had become an expert in the field, and that expertise made the higher charge reasonable.
The point is, low cost does not necessarily leave more money in your pocket. While low cost is a good thing, after accessing, all those other things really do have to be considered.